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Schork Oil Outlook: Traders Think High Prices Justify Higher Prices

Perception trumps reality: high prices become the justification for higher prices.

Here's a reminder:

Apropos the current strength in the market, the common refrain amongst traders and analysts goes something like this: I don’t believe in this market’s strength, but I want to participate while it lasts.

Got that? Traders are so desperate that they are now buying, not on fundamentals, but rather on fear of missing out before this market heads back into the toilet.

Our concern is this: with each passing session it appears more traders are encouraged to “participate,” hence, the market keeps moving higher. That happens enough times and soon you have $100 oil and Matt Simmons all over the tube alleging the Saudis are doctoring their books and that Petrobras and ExxonMobil didn’t just find all of that oil in Brazil. Then, just like we saw last spring, when the price path of the market decouples from the fundamentals, perception trumps reality and high prices become the justification for higher prices. All because the smart money [sic] doesn’t want to “miss out.” -The Schork Report, – 3/26/2009

Since we wrote the above last spring spot crude oil on the Nymex rose from a low of 57.30 in April to a high of 84.45 at the beginning of this year. Thanks in large part to wishful non-thinking and egregious extrapolations of economic headlines by people who should have known better.

Ergo, amongst all the fashionable tag lines in the first half of last year, none was more blindly adopted than the concept of the second derivative to explain the unexplainable, i.e., the rise in U.S. equity and commodity indices. As if social interactions between individuals and firms can be neatly encapsulated by a mathematical function.

In this context, the second derivative was employed by Wall Street touts to give their less-bad-is-good-mantra some intellectual oomph.

The economy was still sinking, but the velocity of demand destruction was slowing. Sell-side pundits wanted us to believe that alleged less bad economic headlines, while still bad, were good in terms of higher order derivatives, hence why the market cheered at the time when it was reported only 1.29 million Americans lost their job in the second quarter.

Then, when it was reported that only 597,000 Americans lost their job in the third quarter and just 208,000 in the fourth quarter… well, break out the champagne.

In this vein, the bulls were making a farfetched assumption that perceived less-bad headlines implied the economy was nearing an extreme value or inflection point and that was good, i.e. the rate of change of the curve along the x axis was decreasing, hence the second derivative talking point.

However, in the real world, with so many conflicting variables in play, plotting out the future path of the economy is somewhat more complicated than looking at a point on a line along the x axis of a Cartesian graph. Analysts at The Schork Report do not dispute the concept that the Great Recession ended last summer. It is just that, every time we take a second look, the economic downturn was actually more bad rather than less so, in spite of all that tut-tutting to the contrary.

For instance, last summer the U.S. Bureau of Economic Analysis released its Comprehensive Revision: 1929 through the first quarter 2009. In it we learned that:

- In the revised estimates, real GDP increased 0.4 per cent for 2008; in the previously published estimates, real GDP had increased 1.1 per cent.

- From the fourth quarter of 2007 — the start of this recession, according to the National Bureau of Economic Research — to the first quarter of 2009, real GDP decreased 2.8 percent at an average annual rate; in the previously published estimates, it had decreased 1.8 percent.

- Real GDP fell 1.9 percent during the four quarter of 2008; more than twice the original estimate of 0.8 percent.

Meantime, on Friday, in addition to the monthly jobs report, the U.S. Bureau of Labor Statistics (BLS) released its annual revision (March 2008 to April 2009) of national estimates of employment. It wasn’t pretty, i.e., it was more bad.

In short, the U.S. government erased another 902,000 jobs (an adjustment of -0.7%) from its estimates for the twelve months ended March 2009, for a total loss of 5.769 million jobs or –4.2 per cent.

The BLS notes this was the largest 12-month net decline in employment in the history of the series, which dates back to 1939. In percentage terms, the -4.2 per cent change is the largest negative 12-month change since April 1958.

In tomorrow’s issue of The Schork Report, we will have more on Friday’s job’s report for January, which was actually less bad, i.e., only 2.542 million jobs were shed from the economy since March… assuming, of course, the BLS does not revise that down by a few hundred thousand come next February’s revision.

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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.